A decade is a long time in any business, but in fixed-income it seems like an eternity. It has been long enough for trading to change beyond recognition. Whereas 10 years ago corporate bonds, for instance, were still mostly traded over the phone, by last year 20% of trading had become electronic, and by 2016 it could reach 37%, according to US research house Tabb Group.

Tradeweb toasts the Thomson years

Tradeweb, one of the firms that has helped to drive this change, passes a 10-year milestone this month. In April 2004, it underwent a significant change in ownership, agreeing to be bought by Thomson, now part of Thomson Reuters.

The US-based operator of fixed-income and derivatives electronic platforms has plenty to celebrate on the anniversary. Revenues, about $95 million in 2004, should be more than $500 million this year, according to its co-founder and chief executive Lee Olesky. Thomson Reuters does not disclose Tradeweb’s revenues, but UK company filings show that its European revenues have risen to over £40 million (see chart).

Looking ahead

The key question is what the next 10 years might bring and, in particular, whether Tradeweb’s success could put it in conflict with some of its owners. While Thomson still has a majority stake, Tradeweb is part-owned by 10 big dealers in the products it trades.

Its intriguing ownership structure dates back to 1996, when it was the brainchild of Olesky and Jim Toffey, who were then running the electronic fixed income business of Credit Suisse First Boston. The norm at that time was that clients trading fixed income went to a single dealer such as CSFB. However, electronic trading was beginning to emerge and made it possible to envisage a trading venue with multiple dealers, which would make clients less dependent on one bank.

That ownership structure persists in part today. While Thomson Reuters holds a majority stake, in 2008 a group of 10 large bond dealers including Barclays, Deutsche Bank, Goldman Sachs and JP Morgan bought a 40% stake in Tradeweb through an initiative called Project Fusion.

Once quite common, the structure is now unusual. BrokerTec, MarketAxess, Turquoise, FXall (and Markit if it goes public) are a few examples of businesses once owned by dealers but now majority-owned by independent operators or the public market.

The benefit of being dealer-backed is obvious. One former Tradeweb executive said: “The combination of its professional approach, and working closely with its dealer owners, has helped to hold market share against competitors that are perhaps cheaper.”

However, the danger of the model is that because fixed income dealing has traditionally been a lucrative business for banks, Tradeweb’s expansion is bringing it into competition with its owners. Another risk is that operators with expertise in equities electronic trading are using it to muscle in on Tradeweb’s turf.

What Tradeweb has going for it is its specialist knowledge of the sector; fixed income products, being more complex than equities, are difficult to shift on to electronic markets.

Tradeweb started with just one product, US Treasuries, which are relatively liquid. As it developed technology suitable for more complex products, it expanded into other government bonds and European credit, then derivatives – including interest rate swaps and credit default swaps. It has also diversified beyond its original institutional client base into interdealer and retail markets.

Users of its platforms now include the buyside, sellside, central banks and hedge funds.

Such expansion is set to continue, according to Olesky: “Our core business model is to use our technology and leverage it into different geographies, different products and different communities.”

Changes in regulation have added impetus to Tradeweb’s growth. Electronic trading has been stimulated by the G20’s post-crisis agenda of shifting trading onto organised marketplaces to increase transparency and reduce systemic risk. At the same time, fixed-income dealing, once the preserve of banks, has been opened up by Basel III banking rules, which have made it more expensive for banks to take bonds onto their balance sheets to facilitate trades for clients.

A disappointing start to this year has underlined the banks’ woes in fixed income, commodity and currency trading. With the Wall Street earnings season getting under way, FICC revenues at the biggest banks are believed to have slumped.

Tradeweb is part of the issue. Electronic trading has eroded banks’ margins in fixed income, and if the dealers with stakes in Tradeweb resist progress and seek to stick to the old high-margin models, it could spell conflict, one former Tradeweb executive said.

Analysts at Morgan Stanley and Oliver Wyman wrote in a recent report that “exchange-like venues” and an “agency-like execution model” were the key to “dramatically reducing the balance sheet tied to execution in liquid FICC markets”. The report added that “banks must decide whether to push change, or to defend the status quo”.

So, are Tradeweb’s interests out of alignment with those of its owners, and is it likely to move away from that ownership structure? Olesky said: “We’ve had terrific support from our investor base across the board. How that might change over the years we’ll have to see, but right now we have a very stable investor base and a supportive board.”

Those sentiments seem to be supported by reports last November that Tradeweb’s bank owners had agreed to stump up tens of millions of dollars to fund a new US electronic corporate bond platform. Olesky declined to comment specifically on those plans but said: “We’ve had really good success in credit in Europe and we are looking at how we can apply that to other regions in the world, including the US and elsewhere.”

One immediate opportunity is that a glut of bond issuance has left investors sitting on record amounts of bonds that they have found difficult to trade. Dealers are trying to do more with less and are turning to electronic platforms to turn over their inventories more quickly and transact more volumes with institutional clients.

Olesky said: “We’re applying technology to solve these problems, such as allowing a much easier search function to allow investors to find the other side of a trade, tapping into communities that allow for greater liquidity and we’re also reducing risk by automating functions that were manual.”

Trading reforms

With the G20 reform of swaps trading, Tradeweb has struggled against more established players, according to some practitioners. Since mid-February in the US, it has been compulsory to trade certain swaps on new platforms, known as a swap execution facility, or SEF. Tradeweb runs both a credit default swap and interest rate swap SEF, which in the last week of March accounted for 7.2% and 6% respectively of overall SEF activity in each asset class, according to data from the Futures Industry Association.

Platforms operated by Bloomberg and interdealer brokers have grabbed a bigger slice of the pie.

Olesky admitted that the new regulatory environment had been a “real challenge to navigate for market participants, in terms of its complexity, timeframe and the costs associated”.

A more pressing concern could be encroachment by new competitors. Tradeweb’s main rivals remain Bloomberg and MarketAxess, but interdealer brokers, exchanges and other independent operators are beginning to encroach on their turf.

One way to fend off competitors, particularly from interdealers, might be acquisitions, according to some market practitioners.

Olesky is less certain: “The majority of our revenue growth has been organic over the last 10 years and we pride ourselves on that. Where there’s things we can do with our technology we’ll do it ourselves. If there’s better opportunities to do things through acquisitions, of course, we’ll look at those opportunities.”

MarketAxess: an independent operator

At first glance, MarketAxess looks much like Tradeweb: a US-based operator of multi-dealer to client electronic platforms for fixed income securities, incubated in a bank, backed in its early years by a consortium of dealers and celebrating a 10th anniversary.

However, the differences reveal as much as the similarities.

MarketAxess has a core franchise in US investment grade, emerging market and high-yield credit, while Tradeweb’s strength lies with government bonds and fixed income derivatives.

Richard McVey, chief executive and chairman of MarketAxess, said: “The banks that backed us did so because they believed the right technological solution for credit was fundamentally different to that required for rates. We have common origins to Tradeweb, but the businesses have developed on different paths.”

Another great difference lies in the nature of this year’s anniversaries: Tradeweb is celebrating 10 years of Thomson Reuters ownership, whereas MarketAxess is marking 10 years as a listed company. Its quarterly filings in January revealed revenues of $239 million last year, 25% up on 2012. It accounts for the majority of US corporate bonds traded electronically, but that represents only around 14% of overall daily volume.

McVey said an independent structure was helping MarketAxess to develop an “all-to-all” electronic platform, enabling institutions, banks and others to trade bonds in one pool. These efforts were bolstered last year by a deal to link up with BlackRock’s Aladdin system, which hosts more than $10 trillion of client assets. McVey said: “Our view of the future is not one that operates without dealers, we just have to find a way that dealers, investors and new alternative marketmakers can all peacefully co-exist.”

He said those alternative marketmakers include buyside firms but also electronic marketmakers from other asset classes. Many are still reluctant to quote bond prices themselves, he added, but they do want to find and respond to matching opportunities – what he called “leading with a price”.

He said it was “a very significant change in their trading process”, requiring refinement of their risk management and compliance systems.”

This article first appeared in the print edition of Financial News dated April 14, 2014